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Press release on the Monetary Council’s meeting of 19 October 2009

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19 October 2009

At its meeting on 19 October 2009, the Monetary Council reviewed the latest economic and financial developments and decided to reduce the central bank base rate by 50 basis points from 7.50% to 7.00%, with effect from 20 October 2009.

The Monetary Council expects domestic economic growth to resume in the middle of 2010. Inflation is likely to exceed the medium-term target temporarily due to the indirect tax increases, and then to move materially below it in the second half of next year. Consistent with the more benign outlook for the world economy, there has been a steady improvement in global financial markets in recent months; however, it remains to be seen whether and for how long this process will continue.

The monthly outcomes for consumer price inflation over the past quarter were below the Bank’s expectations. The persistence of subdued inflation despite the increase in indirect taxes is attributable mainly to restraint imposed by weak demand on pricing. In the Monetary Council’s judgement, the risk that inflation will fall significantly below the 3% target over the medium term has increased.

Available labour market data suggest that the corporate sector has adjusted to weak domestic and foreign demand by moderating earnings growth and sharply reducing employment. Wage moderation is of key importance for firms seeking to maintain their competitiveness. Setting wages by taking into account the protracted recession and the expected low inflation environment may help keep jobs and contribute to a faster economic recovery.

The reliance of the Hungarian economy on external sources of financing can only be reduced if a sustained improvement in external balance is achieved. Maintaining a disciplined fiscal policy approach is required to gradually reduce the country’s vulnerability to shocks. A couple of measures taken by the Government to ensure that this year’s deficit target is met could prove difficult to sustain in the longer run. This is a risk in terms of meeting the budget target for 2010 and poses a threat to the fiscal consolidation process.

There has been a steady and substantial increase in global risk appetite in recent months, leading to a fall in the risk premium required by investors to hold Hungarian financial assets. However, the domestic economy continues to be vulnerable to shocks, which suggests the need for heightened caution in policy-setting.

The Monetary Council decided to reduce the central bank base rate after considering the recent developments in inflation and the macroeconomy as well as in perceptions of risk. Interest rates may be reduced further, if this does not threaten the inflation outlook and if shifts in risk sentiment allow it.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 4 November 2009.

MAGYAR NEMZETI BANK

Monetary Council